Just about six weeks left in 2024. Come January, you’ll be a year older. Or something like that. The new year brings the idea of optimizing your TSP investment profile for the stage of life you’re in. The Federal Drive with Tom Temin gets some idea from certified financial planner Art Stein of Arthur Stein Financial.

Interview transcript:

Tom Temin Let’s start with the fact that you have a bone to pick with something we published recently.

Art Stein Absolutely. There is an article on your website that talked about maximizing TSP returns, and it suggested that the percentage that people invest in the G fund, which is the short term bond fund. Historically [it] has had the lowest rate of return of all the funds, and has had over the last 15 years, but in the last five years done better than the F fund. But anyway, that people should have once they reach age 61 to 65, 80% of their investments in the G fund. And I find this to be, well, just wrong. I mean, I couldn’t disagree with it more. All the studies that I’ve ever seen show that the higher the percentage a retiree has in bonds and bank accounts, the greater their chance of exhausting their investments before they retire. Because the G Fund is considered “safe” — and let’s put that in quotations — because it doesn’t fluctuate in value. It’s never going to go down in value. It’s just going to go up a little bit. And certainly that fluctuation in value, which we call volatility, is an investment risk. But the more important investment risk is having taxes and inflation reduce the purchasing power of your investments over long periods of time. And the G Fund is the most likely — and the F fund too — those are the ones that are going to suffer from that in the TSP because the rate of return is not high enough to keep up with inflation. And when you take the money out, you have to pay taxes and you’re just going to end up with less purchasing power. And over a long retirement, 25-30 years, that could be a killer. And also, we have to keep in mind that the FERS annuity does not have a full cost of living adjustment. Any time inflation is more than 2% fers annuitants receive an inflation adjustment, but it’s less than the rate of inflation so that the purchasing power of their FERS annuity goes down over time too. I mean, I did a calculation assuming that inflation was 3% every year, which would mean that a FERS annuitant would receive a 2% inflation adjustment, and after ten years their purchasing power is down 8%. After 20 years, it’s down 17%. That is a significant amount, especially if the person’s investments are mainly in the G fund.

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Tom Temin I guess if you look at the most possibly aggressive approach you can have to investment earlier in your career versus total safety, what you need to do is set that needle somewhere above utter safety. I guess utter safety is putting all your cash in a mattress. Of course, then you get zero growth. But nothing will happen to the principal until you withdraw it. Aggressive growth, you might sustain losses that you can’t have time to recover in old age. So is it really a matter of balancing that set point between complete safety and total reckless abandon that people have to find?

Art Stein Well, one, this recommendation is pretty close to complete safety, and I would never recommend someone have 100% of their funds in the stock funds. But you need to keep in mind that the risk of losses — historically past performance is no guarantee of future performance — stock market losses were temporary and market losses, market crashes were small compared to the subsequent gains. And people need to have a certain amount in the G and the F fund, let’s say they’re retired, they’re taking out a certain amount of money from their investments every year to live on. Maybe they have 5 to 10 years of withdrawals in the G and the F fund, and then put the rest in the stock funds, some kind of calculation. But when we talk about losses, it sounds like it’s something permanent. And historically, it’s never been permanent.

Tom Temin Yes, that’s right. The Dow Jones Industrial Average fell 500 points in black Monday of 1987. But then the Dow Jones Industrial Average back then was something like 776 in ’82 to 2722 and ’87, but now it’s 40,000. So if you look at that in the long term, that’s a good illustration of what you’re trying to say.

Art Stein Yeah. Well, let me put it a different way. In 1987, they had probably the worst one day stock market crash since the Great Depression, down about 27%. Just a real disaster. But stocks were up for the year. So if you’re invested at the beginning of the year and rode out the crash, you made money. And same thing during COVID in 2020, in March, the C fund was down about 35% from its previous high. Everybody thought it would just keep getting worse and worse. In the end, the C fund was up about 18% for the year. So, yeah, you have to realize there are always going to be losses, there are always going to be bad years. There’s always going to be stock market crashes in our future. But you also have to realize that bonds and bank accounts, you’re bleeding purchasing power every year. And it’s insidious because you don’t realize that. You look at the G Fund, it’s up a little bit each year. No one sits around and calculates, well, yeah, but look what happened to my health insurance costs and lots of my other expenses, the cost of insuring my home and things like that. And that’s what’s going to kill you in retirement.

Tom Temin We’re speaking with certified financial planner Art Stein of Arthur Stein Financial. So to get back to the kind of thesis of the interview, then, should you nevertheless look at your allocations from time to time and have any adjustments in them from what you might have started out with in your 20s or 30s, when you start to reach your 50s-60s?

Art Stein Absolutely. And I would never say just set it and forget it because among other things, if you did that and stocks outperform over time, you have an increasingly high percentage invested in the stock funds. So you need to rebalance every once in a while. You need to think about your allocation. But don’t follow these rules of thumb: “Have a certain percentage based on your age.” No, based upon your circumstances. Based upon how much you expect to need to withdraw from the TSP in the future, and how old you are. If you’re 65, we strongly recommend that our clients assume that they live to 95. Now, not all of them will. But in the United States, people who have good retirement income and good health insurance, which absolutely describes federal retirees, have a much, much longer lifespan than the average American. So assuming you live to 95 is not an aggressive assumption. It’s a reasonable assumption because if you die early, then you don’t have financial problems. But if you assume you die at 85 and you live to 95 and you’ve exhausted your investments at 85, then you have problems.

Tom Temin But as you exceed that 85 and 90, even mid-nineties or so, at that point, your health care expenses are going to rise. I don’t care what anybody says, it’s going to start getting very expensive and you’ll probably start spending down your principal of your estate. But at that point, if you’ve preserved it, then it’s extremely unlikely you’ll outlive it.

Art Stein Yeah, I mean, I’m not saying with the issue of whether you should panic if you are spending down principal or not, but purchasing power. Long life spans. Think how much better health care is going to be in 10 or 20 years than it is now. They’re great in keeping us alive, and we need to be invested in something where it’s likely to increase our purchasing power over time. And historically, that’s been stock investments.

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Tom Temin All right. So going to the other end of life, that is you’re starting out in your career and you are going to at least invest the minimum required to get the full 5% federal matching. At that point, should younger federal workers think about 90% stocks, say?

Art Stein Yeah, younger federal workers can afford to be much more aggressive. And they should be. And it’s not only what percentage they have in stocks, but I would recommend don’t pay attention to the G fund at this point for your bond investments. Look at the F fund. Now, the F fund has not done well over the last five years, but that’s an anomaly. Historically, it’s outperformed the G fund most years, and that’s what one would expect.

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